What Is the Main Difference Between FHA and Conventional Loans?

The main difference between FHA and conventional loans is that FHA is easier to qualify for.

FHA allows higher debt-to-income ratios, lower incomes, lower credit scores, less “steady” employment history, and the list goes on.

In fact, FHA loans were created with the goal of allowing people to become homeowners if they can't qualify for a conventional loan.

So it’s no surprise that these loans have easier approval standards.

Here’s why lenders are more lenient on FHA loan applicants:

FHA loans: The lender is insured by the government against borrower default.
Conventional loans: The lender is not insured by the government against borrower default.

This seemingly small difference means less risk for lenders and easier qualification for buyers: lower rates, lower mortgage insurance, and less-stringent requirements.

The main difference between FHA and conventional loans for many people is whether or not they become a homeowner.

More differences between FHA and conventional

Following are a few ways government backing or lack thereof creates differences between the two programs.

Mortgage Rate Differences

FHA loans often come with lower rates than conventional. Again, government backing lowers risk for lenders, and rates follow risk.

This is especially true for homebuyers with low down payments and lower credit.

According to Optimal Blue, a mortgage rate software company, conventional loan buyers with credit scores below 680 and down payments less than 20% received an average rate of 6.69% during the first quarter of 2023.

During the same period, FHA borrowers received a rate of 6.33%, which is 0.36% lower than conventional. This would equal a savings of about $105 per month on a $350,000 loan by choosing FHA.

However, FHA is not always the cheapest. Those with more than 20% down and a credit score of 740 or higher received a conventional rate of just 6.30% in the first quarter of 2023, beating FHA, says Optimal Blue.

In all, though, strong government backing helps FHA buyers without perfect profiles get better rates.

Mortgage Insurance Differences

There are two main differences between conventional and FHA mortgage insurance.

1. FHA mortgage insurance is permanent while conventional PMI is cancelable

2. FHA mortgage insurance costs the same for all credit scores; conventional PMI costs more for low-credit borrowers.

Buyers with a low down payment and credit score will likely pay higher mortgage insurance rates. Here’s an example, with PMI rates from MGIC.

If you don’t have a perfect borrower profile, FHA mortgage insurance will probably cost you less.

Debt-to-Income Ratio Differences

FHA is much more lenient about your debt-to-income ratio, or DTI.

DTI is the percentage of monthly debt payments versus gross income.

For instance, if you have $10,000 per month in income and $4,000 in debt payments including the future house payment, your DTI is 40. This is because 40% of your gross income is used up every month to service your debt.

Conventional loans allow you to go up to 43-45% DTI. FHA loans have been known to allow DTIs up to 56% for those with compensating factors like cash reserves or high credit.

So whether you have a lower income, or you’re buying in a high-cost area, FHA can help you qualify.

Differences in Seller Perception

Home sellers will accept a conventional offer over an FHA offer most of the time.

Home sellers and real estate agents have the perception that FHA buyers are not as strong. Therefore this buyer might be denied mid-process, leaving the seller in a tough spot.

FHA loans also come with tougher property standards, which could force the seller to make repairs before closing.

Whether the perception matches reality doesn’t matter: sometimes people choose a conventional simply because they know sellers in their market won’t accept FHA.

Cost Differences

Unless you have great credit and at least 5% down, FHA will probably cost less.

Here are example costs for three scenarios.

*Rates and payments are for example purposes only and may not be available. Not a quote or commitment to lend. **Mortgage insurance rates from HUD and MGIC.

FHA and Conventional Loan Differences: FAQ

Is it better to use FHA or conventional?

Those with near-perfect credit and at least 5% down might get more benefits from a conventional loan. Buyers with lower credit scores usually come out ahead using FHA.

Why do people choose conventional loans over FHA?

Some people choose conventional loans over FHA because mortgage insurance is cancelable when you reach 20% equity. Also, home sellers are more likely to choose an offer with conventional financing.

What is the downside of an FHA loan?

The downside of an FHA loan is the upfront mortgage insurance premium that adds 1.75% to the loan amount. Also, monthly mortgage insurance is not cancelable without refinancing out of FHA altogether.

Wrapping Up: Main Difference Between FHA and Conventional

In summary, FHA is the easier option to qualify for. Homebuyers who are “on the edge” of approval might choose this loan type. Still, many high-credit, high-income buyers use it as well.

Run the numbers and approval scenarios with your lender to see which one will work better for you.